Monthly Archives: December 2011

Tents on Tel Aviv's Rothschild Boulevard. The Occupation of Wall Street. Hunger strikes in India. Riots in Greece. These are just some of the expressions of angst and betrayal of youth around the world in protests that human history will forever compare to similar 'hot summers' as the riots of 1968.

But there is something deeper at play here than in 1968. Whether it be the expressions of hope for a better future in Tahrir Square or the expressions of angst of a bleak future that led to the riots in London, to compare 2011 to protests past would be to ignore the deeper elements at play in this current round of protest. This being, primarily, the widespread belief of protesters and Venture Capitalists alike that mainstream Capitalism as failed and that a new model, an unknown model, must arise. These the far-reaching implications can be understood if the grounds for the unrest are reviewed in the context of modern economic history.

Economic history might not be the sexiest of fields, but it is critical for us to understand the pressures that led to the transition from Mercantilism (the governing mode of trade from the 16th through the early 19th century) to Capitalism (which has survived in the West as the dominant paradigm from the 19th century until the present day, despite being challenged partway by the rise and fall of the Communist effort). While my understanding of economic history has gathered around a decade of rust, I'd say the best vantage point to understand that transition was at the point that economists understood the concept of comparative advantage.

In 1817, a man by the name of David Ricardo wrote a book called "On the Principles of Political Economy and Taxation," that chipped away the last supports holding Mercantilism in place, and prepared the grounds for Capitalism to emerge triumphant. It is sometimes hard to remember that until then, kingdoms controlled the economy of the world, and set the terms by which individuals could work and earn their bread. Those kingdoms believed that what was best for the realm was to protect their local industry, and exploit the resources of other sources outside the kingdom to add to its reserves.

Ricardo noted in this important essay that it does not make sense for kingdoms to do everything. Instead, those kingdoms which were good at producing one thing, such as cloth, should focus on cloth production – and leave the wine production to countries that could do that in the most efficient manner.

Nowadays, the idea that a collective should focus on doing one thing well and work with others to trade for what the collective needs seems self-evident. But at the time, the thought that a collective need not be independent was groundbreaking. Thanks to this insight, and the insights of others such as Adam Smith, the elites in societies around the world started investing in ventures that would grow their competitive advantage to increase wealth and prosperity.

Capitalism was born out of this understanding: that it was not the control of trade, but rather access to capital (resources, including money and material), that mattered. Competition was seen as a means to growing the pie for everyone, as investment in firms that had comparative advantages would increase efficiency and effectiveness, generating new resources that could then be reinvested as capital in the creation of new ventures.

Over time, Capitalism was changed and challenged by a number of ideologies, from the free-marketeers who believed that government should have its hands off of the economy (something the intellectual father of capitalism, Adam Smith, might disagree with), to Communists who believed that the free-market element of capitalism was inefficient and biased and so full state control of capital was best. But the underlying tenant, that resources when put in the hands of firms with a comparative advantage would drive creation remained, and the importance of capital as in physical, measurable material was kept at the core of economic thinking. Where Mercantilism put the interests of the collective's resources and capabilities above all, Capitalism put the importance of resource measurement, collection and allocation above all.

It is important to understand this transition because it clarifies a fact that is sometimes forgotten in debates about economic policies and pathways: Capitalism is only one in a succession of ideas for how collectives can improve their lot through leveraging their resources to produce new solutions to human problems. And one should not conclude from the current protests that it is time to roll the progress back; instead, one should see the new economy peeking out from behind the signs and the slogans.

Why now? Because of the speed of trade. The reason Mercantilism was supplanted by Capitalism is that communication technologies and shipping technologies enabled trade to occur at a greater frequency and level of specificity than ever before. Once, a kingdom or collective entity such as a firm would send out a ship to the West, and it would be months if not years until it understood its return on investment. Farmers would labor day in and day out to produce an indeterminate amount of grain, and it was almost impossible to calculate how much more or less grain was needed locally versus in trading nations before the grain would go bad. Around the 18th century technology emerged to enable individuals to rethink what they were producing and with what resources, and for whom, and to privilege the production of certain goods over others based on their relative return on investment (a rate of return determined by comparative advantage). All of a sudden, cross-border trade was not only possible, it was favorable. Capital could be leveraged across the frontier, and Capitalists viewed their ability to leverage resources for development as a messianic gift to humanity – and, therefore, a God-given right that the collective had no right to limit.

In the past fifty years, and particularly in the past ten, an analogous evolutionary jump in the speed of trade has occurred, pushing individuals to demand more. The protests in Tel Aviv are the best example so far, although the Occupy Wall Street movement seems to be heading in the same direction. In the 1950s through the 1990s, Israeli youth knew that they were burdened by their choice to live in Israel — by the national service, the taxes, the special government deals with unproductive segments of the population. But with borders closed, and hostile neighbors, they took such burdens for granted as a means of survival. Then came the 1990s, and the 2000s, and expanded Israeli trade with the Near East, Europe and Far East, and Israel's economic isolation is a faint dream of the past, as are the justifications for protectionism. At the same time, nearly every Israeli young adult is updated minute by minute about the economic opportunities in other countries, as well as the ridiculously high concentration of wealth that Capitalism afforded the richer segments of Israeli society, thanks to protectionism and lack of government regulation for economic concentration. This led to a sense of cognitive dissonance: young Israelis want to live in Israel, to serve their collective, but most of those same individuals protesting have the education and drive to enable them to immigrate from Israel with minimal burden. All of a sudden, they understood they could get more elsewhere – but they decided instead to fight for the justification to stay in Israel.

Israeli society wants the youth to succeed, which is why 87% of Israel's population supported the protests and three times the population of Israel's largest city, Tel Aviv, took to the streets in early September. In time, once the fires of American partisan politics die down, so too will the American people want the youth to succeed, because it just doesn't make sense for a society, its laws and its military to defend the rights of a minority's minority to control resources that should be available to all citizens. But making adjustments in the current system will not be enough. It's time for an economic evolutionary leap.

Mercantilism believed that the economy was in service of the state, of the king. The better the kingdom did, Mercantilism proposed, the better the kindgom's subjects fared. Capitalism rejected this notion, and sought to free the productive class from the state, saying that the state will do best if business is able to leverage its capital in the ways of comparative advantage. The citizens of the state, Capitalism suggested, would benefit from innovations in the creative process and gain in public works thanks to increasing amounts of taxation. But we are at the dawn of a new era: an era where we understand that Capitalism may have provided extra fuel to firms, but it was unable to holistically improve the lot of the people. While firms pushed ahead to create new modes of transportation, computation and healing, they also disregarded the commons in toxic run-off, quarterly downsizing, and myopic reallocation of employment policies. And as the people were able to learn more about how their energy as producers or consumers were being misallocated by firms, they demanded more.

It is too early to tell what the next system will be, but I am willing to make a few bets as to its fundamental tenants. First, the next economic system will seek to free the economy from business, enabling unaligned individuals to contribute their personal energies to collective projects that would provide nearly unlimited energy and creativity for the benefit of the public. We're already seeing bits and pieces of that come through crowdfunding platforms such as Kickstarter, and crowdcreation engines such as Quirky.

Second, the next economic system will demand a non-linear accounting system, one that takes into account the massive growth in stakeholders that any business now has. Previously, a 'bottom line' was gotten by comparing revenue to expenses. Recently, a 'triple bottom line' was proposed to take into account financial, social and environmental impact. The triple bottom line is a good step forward, but I'm willing to bet that we'll soon be taking into account a much more complex set of factors before deciding if a venture is 'worthwhile.'

Third, the next economic system will focus on cooperation and reuse, as opposed to patent walls and litigation. The generation of children growing up using wikis and sharing files will not understand why generations before them were so obsessed with intellectual property control. And yet if we are to incentivize invention, we will need to dream up a much more holistic royalty scheme that will enable inventors to benefit when their ideas are remixed and mashed into new developments.

Last, we will only be able to fully emerge into the next economic system once we have a global understanding of a firm's responsibilities. The borders of countries that defined the last era are legal fictions that made sense while we lived in a world of limited communication and transportation. Tomorrow's global world will need new controls and supports if we are to keep peace and order, and firms will have to interface directly with that superstructure if humanity's creative potential is to be at the core of governance.

Have other ideas for what's next for an economic paradigm? Please do share.